Fed Delivers Dovish Hike; Markets Wanted More

The Federal Reserve (Fed) announced its fourth rate hike of the year, boosting the fed funds rate to a range of 2.25% to 2.5%.

More importantly, policymakers lowered their expectations for future interest rate hikes in the new “dot plot” and acknowledged global financial conditions in the post-meeting policy statement. But it didn’t seem to be enough for markets, and Fed Chair Jerome Powell’s press conference seemed to only reinforce that impression.

The dots were expected to tell the story. As shown in the LPL Chart of the Day, the median member forecast suggested the fed funds rate would rise to a range of 2.75% to 3% at the end of 2019 (or two hikes from current level), then peak at 3–3.25% at the end of 2020 before declining to a “longer-term” rate of 2.75%. This longer-term rate is the best current indicator of the perceived neutral rate, or where policy is neither restrictive nor accommodative for the economy.

Fourteen of the 16 policymakers contributing to the dot plot see the longer-term rate as 3% or below, which was unchanged from September’s iteration of the dot plot. However, 9 of 16 policymakers project the longer-term rate as 2.75% or below (up from 7 in September), and 4 believe the longer-term rate is in line with the current fed funds rate.

“Investors’ attention has largely shifted to the Fed’s commentary on future policy and economic growth,” said LPL Research Chief Investment Strategist John Lynch. “However, we believe this cautious, gradual rate-hike path is the key to supporting moderate economic growth and manageable inflation.”

Still, the S&P 500 Index slid 1.5% for the day after being up about 1% pre-announcement, and closed down on the day of a Fed rate announcement for the seventh straight time. Losses accumulated heavily during Powell’s post-announcement press conference, as investors were fixated on comments about balance sheet runoff, softening inflation, deteriorating global growth, trade tensions, and the Fed’s political independence.

Markets may be jittery right now, but we encourage investors to focus on the fundamentals instead of the headlines. To us, yesterday’s rate hike and the new dot plots indicate the Fed sees enough evidence in economic conditions for rates to hover around the perceived neutral rate. However, the shift downward in 2019 projections shows the Fed has exercised its commitment to flexibility in predicting a slower path of hikes due to signs of weakness in the global economy. This dovish shift in projections aligns with the Fed slightly lowering its 2019 gross domestic product forecast to 2.3% growth (from 2.5% in September). We see these adjustments as another nod to basing policy decisions on incoming data.

As mentioned in our2019 Outlook:Fundamental: How to Focus on What Really Matters in the Markets, we expect the terminal fed funds rate to peak at 3% this cycle, implying three more hikes from the current fed funds rate. The Fed’s pragmatic, balanced approach increases our confidence in the Fed’s ability to execute policy effectively going forward.

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